Is HELOC interest or mortgage tax deductible?

Canada, 24th January: Is mortgage or HELOC interest tax deductible or not? That’s the question baffling many especially after the recent announcement by Jim Flaherty, the Canadian Finance Minister, that mortgage insurance on HELOC will not be available in Canada.

People who had taken mortgage or a HELOC (home equity lines of credit) have been consulting tax planners in Canada as to whether their interest (either full or in part) is subject to tax deductions or not.

As per the rules of the Income Tax Act, in case of money borrowed for getting investment income or business income, any interest paid by the borrowed on such amount is subject to tax deduction.

CRA Decision

Let us see a case referred to the CRA (Canada Revenue Agency) about the possibility of tax deductions on interest amount payments made by the borrower.

The case refers to a person wanting to purchase a new house in Canada and to rent out the home currently owned by him. The house valued at $700,000 has been paid off in full.

Condition where Interest is deductible

The interest paid on new mortgage will not be subject to tax deductions if the person wanting to purchase a new home approaches a money lender for financing it. The reason is that amount to be borrowed is not for earning some money but for buying a new residence, which is considered to be his personal property.

And the person involved in the above case takes a decision for selling his principal residence for $700,000 to his parents which is paid in the form of a promissory note since the latter don’t have the requisite money for paying.

He gets a HELOC or a mortgage and uses the money from such loan to purchase this home back from his parents to be used for renting it. Proceeds of the loan amount are utilized by the parents of the man for paying off the amount of promissory note.

So, this allows the man to rent out the property bought back and the cash to buy his new principal home.

Do you know the logic behind all these steps? Well, the reason is to enable the person meet the CRA’s ‘direct use test’ according to which the taxpayer might rearrange the borrowings as well as the assets’ ownership in order meet the guidelines of this test.